Insider Selling

INSIDER SELLING….I continue to be worried about the economy for a variety of reasons, one of which is that the stock market seems like it’s still overvalued. Brad DeLong provides further evidence on this score from the Wall Street Journal:

According to Thomson Financial, the dollar ratio of insider transactions in July was $32.21 in sales for every $1 in purchases, the highest monthly reading since May 2001. July marked the third consecutive month the ratio topped 20 to 1, a bearish level that hasn’t been sustained for such a period since July through September 2000.

This is just one piece of data and its predictive power isn’t completely clear, but I strongly doubt that corporate insiders are selling stock “just because they need the money.” Rather, they are afraid that their growth prospects aren’t as rosy as the stock market thinks.

So who has a better idea of what a company’s growth prospects really are, insiders or the investment community as a whole? That’s actually not clear, since in my experience insiders are often more nervous than they should be about their ability to make their growth goals, but it’s still a signal worth paying attention to.

UPDATE: In comments, theCoach responds to my remark about the stock market being overvalued by asking for a chart of historic price/earnings ratios. Happy to oblige.

You can see the problem. The chart below shows P/E ratios for the Standard & Poor’s 500 for the past 34 years, and while there’s lots of variation, the average sustainable value seems to be a bit under 20. During the dotcom bubble P/Es peaked at around 28, but then, instead of dropping back to 18 (or even undershooting) after the bubble burst, they dropped to only about 22. P/Es have since gone back up and are now somewhere around 25 (the exact number depends on how you calculate it).

As with insider selling, this is just one data point and there are people who think the market has fundamentally become able to sustain a higher P/E average over time. Maybe so, but that’s what they thought in Japan in the 80s too….

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